As an investor, if you are interested in adding one of the Chinese Internet companies to your portfolio, Baidu (BIDU) might be one look at. Even though it is the largest Internet search company in China, the competition continues to be fierce, and alliances continue to form to chase after market share. This being said, the company will spend a lot of money on infrastructure this year, which may continue to weigh on the value of the stock as short term thinking investors react to the disappointing margins. But I don't think investors should be disappointed because the company is investing in the mobile market, which is the future of China. Let's take a look at alliances that continue to form and the transformation to the mobile market in China.
Baidu and Qihoo's David & Goliath Struggle
Baidu is looking to have competition when it comes to online shopping because Alibaba and Qihoo 360 (QIHU) are joining forces to put up a search engine to rival BIDU. Qihoo, the "David" of Chinese search engines, is less than a year old but aggressively coming at "the Goliath" Baidu, as it tries to chip away at its market share. Presently Baidu has a 67.2% share while Qihoo 360 comes in at 14.9%. Qihoo's alliance with Alibaba is a smart strategic move when it comes to online shopping because the latter dominates China's e-commerce market, which is greater than $200 billion a year.
This battle sometimes looks like a race. Qihoo has sought to grow and compete through strategic alliances. Another example would be its alliance with Sina (SINA) that runs Sina Weibo, which is a large micro-blogging platform. The two companies started to work together the beginning of this year. While this took place, Baidu did not sit idly by. While Qihoo wants Baidu's market, the direct opposite is happening as Baidu also has been going after Qihoo's anti-virus market. So the battle rages on.
Baidu and Sohu Alliance?
Without dragging out too much detail here, I would like to point out this possible alliance that would benefit both companies and help "Goliath" send off that pesky "David." In a nutshell, Sohu (SOHU) is a big video gaming company, while Baidu is for search engines. Sohu has a small portion of the search engine market and Baidu has a large "online videogame" market. In a complex transfer, the two have spoken about an alliance which would send Sohu's search engine business to Baidu and the latter's video gaming business to the former. This would increase Baidu's grip on the search engine business by gaining 5 to 10% more of the market share.
Mobile Market Battle Front
While these two companies battle, Baidu also battles on another front. This is a little bit different because it involves numerous small players- the mobile search market. Easou is a mobile search market leader in China and then we have four other well known players in the stock market battling for market share. I have already mentioned them earlier in this article: Baidu, Sina, Sohu, and Qihoo.
On this front, Baidu has a different strategy and it is expensive. The company is investing quite a bit in its mobile search market in an effort to increase market share. This accounts for its short term drop in profitability. While it is heavily investing in mobile infrastructure, its R&D (as a percentage of revenue) grew to 13.6% as compared to 10.4% a year ago. As the company seeks a bigger share of the market, it's not cheap as it continues to hire R&D employees and spend money on promotion. The company also recorded a 77% increase year-over-year on SG&A spending to drive usage and installation on its mobile market.
Its investment appears to be paying off as the mobile search market grew by 25% to 100 million people last quarter, accomplished through an aggressive marketing campaign. The company is spending quite a bit of money laying a foundation focusing on creating a friendly and easy user experience. If users find the mobile search easy to navigate, this will naturally grow numbers and increase market share. The larger the market base, the easier it is to monetize. If a company has 100 million people using its mobile search engine and increases its ARPU (average revenue per user) by just $0.10, that brings in an additional $10 million in revenue. So everything rests upon how user-friendly its mobile devices will be.
The company has been investing heavily in infrastructure, marketing & research, and development, which shows as its operating margins dropped first quarter of 2013. This year will be a year of investment for the company, so I do not expect to see a lot of growth as much as I do spending, while the company invests in its future which is the mobile market. Investors might be disappointed in the short term drop in margins, but a long-term investor should consider the growth opportunities in the years to come, don't worry about the short term picture. It's a transitional time for China. The nation is going from desktop to mobile, and a mobile platform is an important investment for the Internet Company right now.